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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

Bank A and Bank B have three OTC trades between them. Trade 1 has a mark-to-market value of +USD 40 million to Bank A, Trade 2 has +USD 25 million to Bank A, and Trade 3 has -USD 55 million to Bank A. All three are covered by a legally enforceable bilateral netting agreement. Ignoring collateral, what is Bank A's exposure to Bank B with netting, and what would it be without netting?

With netting, Bank A's exposure is USD 10 million, because 40 plus 25 minus 55 equals 10. Without netting, it is exposed on each positive trade separately, 40 plus 25, which equals USD 65 million. The negative trade is a liability, not an exposure, so it is not added.

  1. AUSD 10 million with netting; USD 65 million without nettingCorrect
  2. BUSD 10 million with netting; USD 120 million without netting
  3. CUSD 65 million with netting; USD 10 million without netting
  4. DUSD 0 with netting; USD 65 million without netting

Explanation

With netting: 40 + 25 - 55 = +10, so the exposure is USD 10 million. Without netting, Bank A loses on the positive-value trades only: 40 + 25 = 65. Option B adds the absolute value of the negative trade, which is wrong, since Bank A's negative trade is a liability and not an exposure.

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